Low Interest Rates’ Impact on Inclusive Growth
Extremely accommodating monetary policies are in place in virtually all the high income countries as well as in increasing number of emerging markets. While aggressive policy actions by the central banks in the immediate aftermath of the 2008/09 global financial crisis certainly helped in braking the precipitous decline of the global economy and may have preventing a repeat of a severe depression of the 1930s style; but prolonged low interest rates today are having longer term adverse consequences for inclusive growth.
A key policy instrument in keeping interest rates close to zero is the so called quantitative easing, the purchase of financial assets by central banks. The direct effect of quantitative easing is to prop up the prices of financial assets. Higher financial asset prices in turn benefit the wealthier segments of the society to the extent that households with higher income are more likely to own more financial assets.
However, quantitative easing is meant to benefit the low income segments as well. Standard theories in economics argue that lower interest rates should lead to stronger investment, which then drive up employment and income, benefiting the rank and file of wage earners as well as creating new jobs for the unemployed. Yet quantitative easing so far has had only marginal impact of increasing employment and household income in most developed economies, and not at all in an economy like Japan.
What is missing is a sustained upturn in business investment, and this is where standard theories in economics are at best incomplete, if not simply wrong. The fact is that prolonged close to zero interest rates poison the operating environment of successful businesses because they allow badly run and failing businesses to survive. Low interest rates also reduce the costs of holding onto bad investment. The net effect is that failing businesses are slow to disappear and the market is clogged up with companies on life support with cheap loans (in its extreme as seen in Japan they become what is known as “zombie companies”).
This means that creative destruction, the very dynamics of economic renewal and rejuvenation, is prevented from exerting its power. Successful businesses are reluctant to invest more because their failing competitors refuse to go away. Suppressed business investment means weaker growth in employment and income, hurting the middle class and lower income households.
Prolonged low interest rates are making income distribution worse and economic growth less inclusive.